Big no longer beautiful

Bank mergers to take a back seat

Merger among public sector banks, on the government’s agenda ever since reforms began, now seems to be off the priority list. The idea was given a special push in P Chidambaram’s 2005 Budget Speech and bank chairmen thereafter picked it up on cue. Equally on cue, bank trade unions vehemently protested and moved those political parties which would give them a hearing. With Mr Chidambaram no longer shepherding the finance ministry, the idea has now lost some of its backers. The last nail seems to have been driven into the coffin of the idea, for the time being at least, by the Reserve Bank of India downgrading its priority and instead declaring financial inclusion to be very important.

Merger between public sector banks was initially pedalled on grounds of efficiency and competitive strength and also by the fact that the largest Indian banks were nowhere in the top global banking league. But the case of merger was never made out on the basis of numbers — the size-related performance of banks, both globally and nationally. Globally, there has been little correlation between size and profitability and a key study has shown that cost in relation to size shows a U curve, going down initially and then up. Recent banking experience points in opposite directions. The international financial crisis has clearly established that big is not necessarily beautiful when it comes to banks and, what is more, leading developed market regulators are now actively considering ways to ensure that banks do not become too big to fail. On the other hand, Indian public sector banks, which sailed through the crisis virtually unscathed, have lately gone in for comprehensive adoption of information technology, which enables them to control costs while expanding operations.

There can be no case for keeping alive a weak bank. Even those at the border line that need periodic recapitalisation independent of the need to handle growing business, are a drain on the exchequer and a headache for finance ministers. It also makes sense in India to merge banks which do not have overlapping geographical spreads and differ in terms of strength. Thus, a strong bank with a predominantly southern network can usefully acquire a weak bank with an eastern network. There is also no compulsion to retain the separate identities of undifferentiated banks. But an Indian merger will not result in the same kind of cost cutting that a business-driven merger will in most geographies where it inevitably results in one set of senior managers being asked to go. The impact of a merger in India on the salary bill can, in fact, be adverse, with the lower set of employee compensations being inevitably raised to the level of the higher. The profitability and health of Indian banks are primarily driven by historical asset quality which does not change even as CMDs and executive directors come and go. This is true of institutions like Corporation Bank and Oriental Bank of Commerce which are not the biggest but among the more efficient. Besides, the need for local familiarity, not a strong point of behemoths, has gone up lately with greater emphasis on knowing the customer and financial inclusion. While transaction costs, irrespective of size, can be brought down with the adoption of IT, staff are invariably easier to manage and motivate if their numbers do not get too big.